2005 Wrap-up

U.S. stocks ended the year on a sour note. For the week, the Dow dropped 1.5%
and the S&P500 fell 1.6%. Declines were seen across the board. The Transports
declined 1.7%, and the Utilities slipped 1.4%. The Morgan Stanley Cyclical
index dipped 1%, and the Morgan Stanley Consumer index declined 1.3%. The small
cap Russell 2000 dropped 2%, and the S&P400 Mid-cap index declined 1.4%.
The NASDAQ100 fell 2.3%, and the Morgan Stanley High Tech index shed 2.1%.
The Semiconductors dropped 2.6%, reducing 2005 gains to 10.7%. The Street.com
Internet Index and NASDAQ Telecommunications index declined about 2%. The Biotechs
lost 1%. The Banks fell almost 2%, and the Broker/Dealers declined 1.3%. With
Bullion jumping $14.20, the HUI gold index rose 2.2%.

For the week, two-year Treasury yields rose 3 basis points to 4.40%. Five-year
government yields gained 3.5 basis points to 4.35%. Bellwether 10-year Treasury
yields increased 2 basis points for the week to 4.39%. Long-bond yields dipped
one basis point to 4.54%. The spread between 2 and 10-year government yields
ended the year at negative one basis point after beginning the year at 117.
Benchmark Fannie Mae MBS yields were unchanged at 5.75%, this week slightly
lagging Treasuries. The spread (to 10-year Treasuries) on Fannie's 4 5/8% 2014
note was about unchanged at 38, and the spread on Freddie's 5% 2014 note was
unchanged at 39. The 10-year dollar swap spread increased 0.25 to 55. Junk
bond spreads widened 5 basis points or so. The implied yield on 3-month December
'06 Eurodollars rose 3 basis points to 4.795%.

December 29 - Financial Times (Richard Beales): "Junk-rated US companies
borrowed a record $295bn in the loan market this year, trumping 2004's volume,
itself a high. Meanwhile, issuance of high-yield bonds dipped 26 per
cent this year compared with last year. The contrast partly reflects a transfer
of some financing activity to the so-called leveraged loan market from the
high-yield bond market, which experienced several rocky patches this year
- notably during the turmoil sparked by the rating downgrades of General
Motors... Steven Miller, managing director at Standard & Poor's Leveraged
Commentary & Data, says that heavy issuance of collateralised loan
obligations - loan portfolios repackaged and sold in slices bearing different
levels of credit risk - underpinned demand for loans. That in turn was
fuelled by investor appetite for CLO instruments, which offer extra yield
compared with direct investments in similarly-rated loans."

Freddie Mac posted 30-year fixed mortgage rates declined 4 basis points to
6.22%, a nine-week low but up 41 basis points from one year ago. Fifteen-year
fixed mortgage rates dipped 3 basis points to 5.76%, yet were up 53 basis points
in a year. One-year adjustable rates fell 7 basis points to 5.15%, an increase
of 96 basis points from one year ago. The Mortgage Bankers Association Purchase
Applications Index declined 4.5% last week. Holiday-week Purchase Applications
jumped 14.6% from one year ago, with dollar volume up 18.7%. Refi applications
sank 11.2%. The average new Purchase mortgage slipped to $236,300, while the
average ARM increased to $354,600. The percentage of ARMs was little changed
at 32.5% of total applications.

December 29 - Financial Times: "The US asset-backed securities market celebrated
its 20th year by issuing more than a trillion dollars worth of bonds for the
first time and developing a new liquid market in derivatives based on ABS instruments.
That was 2005. In 2006 the fast-growing market will be entering a new era as
issuers and investors face the implementation of rigorous new standards aimed
at improving disclosure... The first ABS instruments were issued in 1985, when
issuance totalled just $1.2bn. In 2004, ABS issuance overtook traditional corporate
bonds for the first time, and November saw issuance for this year break the
$1,000bn mark."

International reserve assets (excluding gold) - as accumulated by Bloomberg's
Alex Tanzi - were up $540 billion, or 15.4%, over the past 12 months to a record
$4.046 Trillion.

December 29 - Bloomberg (Todd Prince): "Russia's foreign currency and gold
reserves, the world's sixth biggest, rose to a record $174 billion as of Dec.
23 as revenue from oil exports surged. The reserves, which have climbed more
than 40 percent from a year ago, increased by $2.7 billion in the week..."

December 28 - Bloomberg (Koh Chin Ling): "China, the world's biggest wheat
and rice producer, said overseas sales of farm goods may reach a record $26.5
billion this year after new incentives encouraged exporters to ship more products
such as corn. Growth in agricultural exports, worth $23.4 billion in 2004 and
$16 billion five years ago, have made China the world's fifth-largest farm-goods
supplier..."

December 29 - Bloomberg (Joshua Fellman): "Hong Kong's exports grew by more
than a 10th for a fourth straight month in November as the city's port handled
more Chinese-made computers and electronics en route to markets such as Europe
and Japan. Overseas sales rose 11.5 percent from a year earlier to HK$200.4
billion ($25.9 billion)..."

Asia Boom Watch:

December 27 - Bloomberg (Mayumi Otsuma): "Japan's consumer prices rose last
month for the first time in two years, gains the central bank says need to
be sustained before changing its policy of keeping interest rates at almost
zero to beat deflation. Core prices rose 0.1 percent from a year earlier, the
first increase since October 2003, and only the second in seven years..."

December 27 - Financial Times (Khozem Merchant): "Indian companies are ending
2005 with a flurry of overseas deals, capping a trend of the past year that
saw a record $10bn worth of mergers and acquisitions involving Indian assets
and a 52 per cent rise over the number of deals completed in 2004, according
to a survey by KPMG. About 40 per cent of the transactions by number - totalling
$2.83bn in value - involved foreign companies expanding into India, according
to the KPMG data."

December 27 - Bloomberg (Netty Ismail and Sumit Sharma): "When Merrill Lynch & Co.
decided to spend $30 million on bricks, mortar and bankers in 1995 taking Indian
companies public, there were hardly any new shares to sell in the world's largest
democracy and second-most-populous nation. A decade later, Merrill is making
more than twice that initial investment and earning more annually than any
of its competitors.... India, considered an also-ran among Asia's capital markets
as recently as 1998, is now the fastest growing for selling new stocks and
bonds."

December 29 - Bloomberg (Seyoon Kim): "South Korea's industrial production
posted its biggest increase in more than six years in November, boosted by
record exports and an increase in consumer spending. Factory output gained
a seasonally adjusted 5 percent from October... Industrial output climbed 12.2
percent in November from a year earlier, following an 8.2 percent increase
in October..."

December 29 - Bloomberg (Anuchit Nguyen): "Thailand's jobless rate fell to
the lowest in almost five years in November as farms, manufacturers and hotels
increased hiring, the government said. The unemployment rate fell to 1.2 percent..."

December 27 - Bloomberg (Shamim Adam): "Singapore's factory production unexpectedly
rose in November from the month before, the longest string of gains in more
than a year... From a year earlier, output rose 22.4 percent in November."

Unbalanced Global Economy Watch:

December 28 - CFO Magazine (Stephen Taub): "It looks like 2005 is the hottest
year for mergers and acquisitions since 2000, the peak of the stock-market
boom. According to a preliminary report by Dealogic released on December 21,
just prior to the traditionally quiet holiday week, global M&A volume
increased 38 percent, to $2.9 trillion, compared with $2.1 trillion in
2004. In the fourth quarter alone, reported Dealogic, volume topped $783.4
billion, making it the largest quarter of the year and the fourth-largest on
record."

December 27 - Reuters (Alistair MacDonald and Mark Meadows): "European companies
raised $213 billion in equity and equity linked markets this year, the highest
tally since the technology boom of 2000, with bankers and investors cautiously
hopeful of similar levels next year. Emerging markets, private equity funds
and companies needing to finance mergers and acquisitions were the primary
drivers behind the 14 percent increase over 2004, figures from financial data
provider Dealogic showed."

December 28 - Bloomberg (Harry Papachristou): "Greek mortgage lending growth
accelerated to a two-year high in October as Greeks rushed to take out home
loans before property taxes rise next year. Mortgage loans to households climbed
27 percent to 40 billion euros ($47.6 billion), the Bank of Greece said..."

December 29 - Bloomberg (Tracy Withers): "New Zealand consumers borrowed 15.2
percent more in November for housing and consumption than a year earlier, according
to figures from the Reserve Bank."

Latin America Watch:

December 29 - Bloomberg (Peter Wilson): "Venezuela's economy grew 9.4 percent
in 2005 as President Hugo Chavez boosted government spending and increased
subsidies for the South American country's poor."

Bubble Economy Watch:

December 26 - BusinessWeek (Roben Farzad): "While workaday traders and portfolio
managers were struggling to generate returns in 2005, one corner of Wall Street
was thriving: mergers and acquisitions. When the books close on the year, U.S.
M&A activity likely will have touched $1 trillion, up from $824 billion
in 2004, according to Thomson Financial. Many signs point to an acceleration
in deals in 2006. The hottest sectors, according to market watchers: finance,
technology, and energy. Plus anywhere cash-rich private-equity funds care to
dabble. Record inflows into private-equity funds are giving them plenty of
ammunition..."

December 28 - Marketwatch: "Companies planned to shell out record amounts
to buy their own shares and other public companies in 2005, which could be
a positive sign for stocks next year, TrimTabs Investment Research said...
The Santa Rosa, Calif.-based liquidity tracker reported that 1,012 U.S. public
companies announced $456 billion in stock buybacks this year, breaking the
previous record set in 2004 when 728 companies said they would repurchase $312
billion worth of their own stock. Additionally, TrimTabs reported cash takeovers
of public companies amounting to $277 billion were announced in 2005, another
annual record."

December 27 - The Wall Street Journal (Stephanie Kang): "After a few slumping
weeks in early December, consumers came back to stores in the last days before
Christmas to deliver a solid, if not spectacular, holiday season... Holiday
spending climbed 8.7% ahead of last year, according to SpendingPulse, a retail-sales
data service from MasterCard International's MasterCard Advisors unit. Demand
for flat-panel television sets, MP3 players and digital cameras helped spur
gains, as did sales of home furnishings."

December 27 - Dow Jones (Lavonne Kuykendall): "Holiday shoppers spent $30.1
billion online this year, a 30% increase from last year, and accounted for
more than one quarter of all holiday shopping dollars spent, according to a
survey of Internet users..."

"Project Energy" Watch:

December 28 - AP: "So many people crush the banks to get on board an initial
public offering that the police have to be called out. Some Saudis disappear
from work during trading hours, and teachers bring their laptops to class to
trade stocks. Saudis have stock market mania, and the obsession is as close
to gambling as one can get in a kingdom that bans it. Five years ago, about
50,000 Saudis had dealings with the stock market. Today, there are more than
2 million active investors in a country of 26 million people. 'For some people,
it's an addiction that's almost akin to the addiction to the casinos of Las
Vegas,' said Prince Mohammed Al-Faisal, a businessman. The index went up by
85 percent in 2004, closing at 8200 at year's end. This year, it has grown
by more than 100 percent."

Mortgage Finance Bubble Watch:

"The median price of an existing home in California in November increased
16.2 percent and sales decreased 11.2 percent compared with the same period
a year ago, the California Association of Realtors (C.A.R.) reported... "The
California housing market continues to experience year-over-year double-digit
price appreciation, which is consistent with our expectation that the statewide
median for 2005 will increase by 16 percent over last year," said C.A.R. President
Vince Malta. Closed escrow sales of existing, single-family detached homes
in California totaled 579,560 in November at a seasonally adjusted annualized
rate... Statewide home resale activity decreased 11.2 percent from...November
2004... C.A.R.'s Unsold Inventory Index for existing, single-family detached
homes in November 2005 was 3.9 months, compared with 2.8 months for the same
period a year ago." Median single-family prices were up $76,420 (16.2%) over
the past year and $163,939 (24%) over two years. Median condo prices were up
$56,370 (14.9%) over one year and $133,930 over two years. It is worth noting
the marked slowdown in sales activity in some of the more expensive markets.
The Monterey Region posted a 23% y-o-y decline in November sales, Northern
California declined 25.9% y-o-y and Santa Barbara County declined 23.6%.

December 29 - "The pace of Florida's housing market eased somewhat in November
-- traditionally a slower month for home sales -- with statewide sales of existing
single-family homes totaling 17,219 for a 1 percent increase over last year...according
to the Florida Association of Realtors... The statewide median sales price
rose 31 percent in November to $250,500; a year ago, it was $191,300. In November
2000, the statewide median sales price was $117,900, which is an increase
of about 112 percent over the five-year period."

2005 Wrap-Up:

The Dow ended the year down 0.6%, with the S&P500 up 3.0%. Ten-year Treasury
yields rose only 14 basis points over the past year, with benchmark 30-year
mortgage rates up about 40 basis points. U.S. and global growth was solid -
not too hot, not too cold. Core inflation was sanguine. It is, then, tempting
to view the year as relatively uneventful and benign. It was anything but.

The story of 2005 is one of an unrelenting and expansive U.S.-based Credit
Bubble and the Prolific Global Liquidity Glut. The inflationary benefits to
the U.S. economy and markets notably waned, especially relative to others.
Coming into the year, a dollar crisis and/or spike in U.S. market yields appeared
leading candidates to finally force a reining in of excesses and the commencement
of long-overdue adjustment. The global leveraged speculating community seemed
poised to disappoint. There was palpable vulnerability with respect to the
Mortgage Finance Bubble. But financial crisis was not in the cards, not with
the Fed's pre-ordained interest rates and a financial sector determined to
expand U.S. Credit at unprecedented levels. At the same time, global central
bankers remained acquiescent to rampant asset inflation and leveraged speculation,
and very much still content to balloon their balance sheets with American securities.

Rather than one of tightening financial conditions and the risk of dislocation,
the financial backdrop developed into only greater - manifestly unprecedented
- accommodation. The emboldened and now firmly Global Wall Street Finance Liquidity
Machine was left to its own devices, and the results were spectacular. Unparalleled
global Credit inflation provided a powerful allure of easy profits for speculators,
dealmakers, lenders, investors and businesses the world over. Credit and speculative
excess ran to new extremes and enveloped markets across the globe.

Here at home, Non-Financial Debt growth rose at the strongest rate since the
mid-1980s. Total U.S. mortgage debt (TMD) growth may have reached $1.4 Trillion
during 2005. This would be an increase of almost $200 billion from 2004's record
increase of $1.214 Trillion - the first year growth exceeded $1 Trillion. For
perspective, TMD expanded $500 billion during 2000, $660 billion during 2001,
$820 billion during 2002, and $990 billion during 2003. TMD growth averaged
$271 billion annually during the nineties. Bank Real Estate loans increased
$358 billion this year, compared to an annual average of $214 billion during
the first five years of the decade. Collateralized Mortgage Obligation (CMO)
issuance was up 23% from 2004 to $1.011 Trillion (from Bloomberg). Mortgages
fueled record ABS issuance. Meanwhile, the 2006 lending limit on Fannie and
Freddie's conventional mortgages was increased $57,350 to $417,000.

The year will see new records set for both new and existing home sales. Home
price inflation accelerated during much of the year, with Household Net Worth
likely expanding by about 10% ($4.5 Trillion) to a record $52 Trillion. Personal
Income increased 5.2% (Nov. '04- Nov. '05), and Personal Spending jumped 5.8%.
Monthly Trade Deficits rapidly approached $70 billion, while annual Current
Account Deficits will soon surpass $800 billion. The growth in "Rest of World" holdings
of U.S. Credit Market Instruments increased to about $800 billion this year,
after averaging $450 billion during the first five years of the decade ($166bn
avg. during the '90s). The World is absolutely awash in dollar balances.

From Thursday's Financial Times (James Politi and Lina Saigol): "Companies
around the world signed [M&A] deals worth $2,900bn in 2005 - a 40 per cent
increase over last year - boosting investment banks coffers while Goldman Sachs's
dominance as the top adviser on mergers and takeovers was confirmed. A small
jump in deal activity had been expected this year, but the extent of the recovery
was a welcome surprise to many on Wall Street and in the City of London. Investment
bankers, lawyers, consultants and other advisers are expecting to see a similar
level of dealmaking - if not more - in 2006." From CFO.com (Stephen Taub): "In
the fourth quarter alone, reported Dealogic, volume topped $783.4 billion,
making it the largest quarter of the year and the fourth-largest on record.
In the United States, volume topped $1.1 trillion in 2005, a 30 percent increase..."

Global private equity deals are said to have reached a record $494 billion
(from Dealogic). From Wednesday's Financial Times (Peter Smith): "America may
be the home of the leveraged buy-out but it is Europe that has become the world's
most fertile hunting ground for private equity. The value of deals this year
rose to a record of more than $180bn... Of Europe's top 10 LBOs, seven took
place this year..." From Reuters (Alistair MacDonald and Mark Meadows): "European
companies raised $213 billion in equity and equity linked markets this year,
the highest tally since the technology boom of 2000..." "Japanese firms are
on course to complete overseas deals worth more than double what they managed
in 2004..." (from Scotsman.com). From the FT's Richard Beales: "Junk-rated
US companies borrowed a record $295bn in the loan market this year." And from
today's Washington Post (Ben White): "According to preliminary estimates, public
companies bought back about $400 billion worth of their shares in 2005, shattering
the previous record of $257 billion set last year."

U.S. equities badly lagged the global boom. Our stocks clearly suffered from
the heated competition from scores of hot asset markets overseas. Moreover,
the U.S. services-based economy is relatively underexposed to companies and
industries benefiting from the world-wide inflationary boom in energy and commodities.
At the same time, we have some key industries - autos and airlines, to name
two - that are on the losing end of newfound inflationary manifestations. The
enormous American mortgage-lending and banking super-industries are also losing
relative appeal in the unfolding environment. Additionally, U.S. equity valuations
increasingly suffer from the nature of intransigent Credit Bubble financial
excess. Not only does it today require higher interest-rates to impose necessary
financial conditions tightening, Credit and asset Bubbles must inevitably pop.
U.S. stocks may appear cheap relative to ballooning earnings, but certainly
not on a risk-adjusted basis.

Ten-year Treasury yields ended the year at 4.39%, a one basis point inversion
from the two-year's 4.40%. With all the attention the so-called "inversion" is
receiving, I'll make a few brief comments. First off all, 10-year yields remain
above the current 4.25% overnight "Fed funds" borrowing rate. Three-month T-bills
still yields remain slightly below 4%. It is also worth noting that "repo" (short-term
securities funding) rates these days consistently trade below Fed funds, often
significantly. More importantly, we today operate in a Global Wall Street/Securities
Finance and massive Global Leveraged Speculating Community environment. Traditional
pricing signals provided by the shape and steepness of the yield curve cannot
be expected to operate in today's most atypical environment.

The Marginal Buyers of Treasury and Agency securities these days are foreign
central banks deluged with dollar liquidity (and insignificant funding costs).
There is also the key issue of global leveraged players tapping inexpensive
funding sources, such as borrowing in yen, euros and francs. It would be quite
illuminating to know the scope of liquidity created in the process of borrowing
cheaply in Japan to leverage in higher-yielding U.S. and emerging debt securities.
A fortune could have been (and likely was) made borrowing in Japan to purchase,
say, Brazilian bonds. The Brazilian real rose better than 30% against the yen,
while Brazil's long-term bonds posted double-digit returns. It would, as well,
be fascinating to know the size of short positions in Japanese government bonds
used as a cheap funding source for securities speculation across the globe.
There is certainly no inversion between 10-year U.S. yields and overseas borrowing
costs. Surely, today's 2/10 Treasury "inversion" is symptomatic of the Global
Liquidity Glut, providing little in the way of relevance for economic analysis.

As for economic analysis, the fourth quarter provided further evidence that
Europe and Japan are emerging from their respective malaise. Concurrently,
perceptions hardened that the U.S. housing market was softening. The risk of
over-heating and the necessity for problematic Fed tightenings have apparently
abated. Energy prices are generally thought to have peaked. But this sanguine
view downplays Global Liquidity Glut dynamics. The global monetary system has
completely lost its bearings, and such a circumstance is not known for sanguine
outcomes. The unbalanced global economy is more energized today than it was
one year ago, while financial conditions are more accommodative. It is conventional
wisdom that U.S. markets and the economy are now several years into a post-Bubble
recovery. The past year has provided convincing evidence that the protracted
U.S. Bubble has become only more unwieldy and global in stature.